If all people suddenly have an extra $2,000 in their pockets before Super Bowl Sunday, what happens to the cost of TVs? What happens to the supply of TVs? Costs go up (by a lot), and supply goes down (by a lot). Well, from March 2020 to now, that’s the road we’ve been on.
It turns out that if you print $8 TRILLION and insert it into the economy willy-nilly, there’s a price to pay. All that cash made prices go up, and inventories fall. It wrecked supply chains and changed how some businesses do everything, especially among the workforce. It made many people leave the workplace, want to work less, or change the type of work they’ll do. That exacerbated a longer-term population problem because there are fewer younger people to fill the spots older people had. Less labor for many positions made wages go up for a lower standard of work.
Then, after almost 20 years of artificially free and nearly free money (low-interest rates) propped up by politicians and the Fed could no longer continue because inflation was eating everyone’s lunch, rates were on the rise for the first time in forever. Here’s the deal with that, though, they raised rates so fast and broke a few things. It is a statistical fact that a single 0.25% increase in the Fed’s core rate takes as much as nine months to be felt. This time the Fed increased the rate from 0% to 5% in like 15 months. Never happened before—not even in the 70s.
A few banks made indescribably dumb bets that interest rates wouldn’t go up and got killed (Silicon Valley Bank, Signature Bank, First Republic). The interesting thing about that is the Fed was running around telling everyone inflation was “transitory” when they needed to sell bonds for all the money they printed. Many of the buyers of those bonds were banks because they had a truckload of excess deposits from the Fed’s money printing machine. The Fed was saying inflation wasn’t that big of a deal, so the banks were ok with putting those excess deposits in government money at historically low rates. Then, once the bonds were sold, the Fed changed its tune and went from a “transitory” attitude toward inflation to a “kill inflation at all costs” mindset. So, when many customers became worried and started pulling their dough, those banks couldn’t get out of the bonds they bought because the Fed raising rates made them worthless. And there you have it–bank failures.
But those banks shouldn’t bother you that much. They weren’t very smart to trust what the Fed was saying without hedging the bond investment (kinda like owning insurance). Most banks are fine right now and pretty strong. But all this focus on the strength of banks WILL force them to tighten up. They already have and will continue to do so because when their strength is questioned, the loans they issue will be increasingly conservative.
You might ask, if banks are pretty strong, why is their condition in question? Commercial Real Estate. By 2025, $1.5T in commercial real estate will have to be refinanced. About half of that paper sits with regional and community banks. If the value of the real estate has gone down (much of it has by 15-20%) and the occupancy is down (in office properties by as much as 40%), then the property might be upside down on debt with a third the cash flow to pay a loan that will now be 500% more expensive with tighter credit conditions. This will require property owners to have serious cash on hand to make the refis work, which many don’t have, and banks will be on the hook.
Will more banks fail because of this? Maybe. What’s more likely is that those banks will have to “batten down the hatches” until the storm passes—which means that getting a loan will be pretty tough. It’s been one ridiculous mistake after another, and here we are.
But fear not. The economy is still doing pretty well, considering. The consumer is still somewhat strong, and businesses are still spending. But now may be a time to take a step back and reconsider putting all your financial eggs (especially lending eggs) in one basket. Contractors are usually the first to get hit when banks tighten, so if you need help with insights or a model to take on the current environment, we have a Facebook group (which some of you may have come from to read this) that we invite you to join. No sales pitches, just building a community of contractors where we can all discuss and share financial best practices, tips, and tools to help you become a multi-million dollar contractor.
Check out the group here and if you have any questions about developing a finance strategy or just need a smarter approach to contractor equipment financing, give us a call. Sadoff can help.